Bitcoin: digital gold or digital cash? Both.

Proponents of Bitcoin as ‘digital cash’ place more emphasis on the accessibility aspect, arguing that its transaction fees should be low, whereas proponents of Bitcoin as ‘digital gold’ are more focused on its security, arguing that this should not be compromised by efforts to lower costs.

In my opinion Bitcoin is and will be both: digital gold and digital cash.

Cash and gold aren’t that different

The vision behind Bitcoin emerged from the cypherpunk movement, which over the course of two decades pursued the development of ‘digital cash’, also named ‘digital gold’. These two words are more alike than it may seem on the surface.

The definition of cash is “money in coins or notes” and “money in any form, especially that which is immediately available”. The etymological origin of the word cash is thus:

In order for cash money and its value to remain ‘immediately available’, it must have the possibility to be stored privately and securely. This is why, historically, most lasting forms of cash have gravitated towards forms that are durable, so they cannot be destroyed by time, and compact — so they can be easily stored in a secure environment like a vault.

As a consequence, anyone who pursues the notion of a durable standard of ‘digital cash’, must also put a significant value on security. Cash that cannot be stored securely is useless, and forms of cash that have better security characteristics will, ceteris paribus, win out over cash with inferior security. India is a good example, where private gold holdings are valued at $770 billion, versus at the most $210 billion for rupee notes.

The most clear way in which Satoshi explained Bitcoin as digital gold was in a 2010 forum post:

As a thought experiment, imagine there was a base metal as scarce as gold but with the following properties:- boring grey in colour- not a good conductor of electricity- not particularly strong, but not ductile or easily malleable either- not useful for any practical or ornamental purpose

and one special, magical property:- can be transported over a communications channel

If it somehow acquired any value at all for whatever reason, then anyone wanting to transfer wealth over a long distance could buy some, transmit it, and have the recipient sell it.

The bridge from gold to cash

Satoshi was right in my opinion: Bitcoin can be both a secure store of value, as well as a liquid medium of exchange used for small size payments. The solution is to accept and embrace an ecosystem with division of labor, where each sector prioritizes a different part of the solution.

In the case of Bitcoin, you can let one part of the ecosystem prioritize security, while the other focuses on convenience and speed. I’ll let Hal Finney, the first ever person to receive a Bitcoin transaction, explain:

“Actually there is a very good reason for Bitcoin-backed banks to exist, issuing their own digital cash currency, redeemable for bitcoins. Bitcoin itself cannot scale to have every single financial transaction in the world be broadcast to everyone and included in the block chain. There needs to be a secondary level of payment systems which is lighter weight and more efficient. Likewise, the time needed for Bitcoin transactions to finalize will be impractical for medium to large value purchases.

(…) Most Bitcoin transactions will occur between banks, to settle net transfers. Bitcoin transactions by private individuals will be as rare as… well, as Bitcoin based purchases are today.”

Finney wrote this in 2010. In my discussions with developers in 2012–’13, this was the prevailing idea of long term scaling: specialized custodians would store bitcoins and issue easily tradable deposit tokens, just like what happened throughout history with gold banks issuing gold backed paper money—only this time the users of the bills would much more easily be able to audit the reserves backing them.*

And that has become our reality today. Western Bitcoin exchanges process over $80 million in Bitcoin off-chain transactions per day; Bitcoin bank Xapo processes 500,000 off-chain Bitcoin transactions daily; Bitcoin gambling site PrimeDice processes 13 million off-chain Bitcoin bets per day. And so on. Cheap, high volume Bitcoin transactions are here already — though they require trust in a third party.

Modular scaling

Little did we know a few years ago that Bitcoin core developers would produce something even better than an enterprise network on top of the blockchain; technology that truly eliminates the need for trusted parties to serve as middle men. I’m talking about second layer solutions such as the Lightning Network, Sidechains, and MimbleWimble.

Scaling software solutions in a modular way is considered good digital hygiene. Here’s how Unix guru Eric Steven Raymond explains the principle:

“The only way to write complex software that won’t fall on its face is to hold its global complexity down — to build it out of simple parts connected by well-defined interfaces, so that most problems are local and you can have some hope of upgrading a part without breaking the whole.”

You do not build a networking protocol by shoving everything and the kitchen sink all into one layer; trying to solve every single problem for every single use case world wide in one massive giant glob of all encompassing code. That doesn’t work! Instead, you create a series of layers; with each layer focused on solving just one part of the overall problem extremely well, extremely efficiently, and as simple as possible.

Conclusion

The question whether Bitcoin ought to be digital cash or digital gold represents a false dichotomy: it can be both a secure and accessible form of money. By embracing modularity, the main Bitcoin blockchain can act as a maximally secure settlement layer, while second layer payment channels serve as pipelines for fast, high liquidity transactions.

Note added on 6/6/’17

Hal Finney’s view on Bitcoin scaling may have been informed by Nick Szabo’s concept of bitgold. Szabo comments in a recent article ‘Money, blockchains, and social scalability’: “When I designed bit gold I already knew consensus did not scale to large transaction throughputs securely, so I designed it with a two-tier architecture: (1) bit gold itself, the settlement layer, and (2) Chaumian digital cash, a peripheral payment network which would provide retail payments with high transactions-per-second performance and privacy (through Chaumian blinding), but would like Visa be a trusted third party and thus require a “human blockchain” of accountants, etc. to operate with integrity. The peripheral payment network can involve only small value transactions, thereby requiring much less of a human army to avoid the fate of Mt. Gox.”